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First Quarter 2014 Review

Managing Expectations

Many expected the first months of 2014 would be uneventful, with markets pausing after their impressive run last year. Looking at the data from the first and last days of the quarter, such a view would appear to make sense. However, what lays between those two data points shows a very different story. With headlines so far this year covering everything from lackluster economic data to geopolitical tensions, it was undoubtedly a volatile quarter in what was expected to be the beginning to a quiet year. It seems that no matter how well we manage expectations, we can still be surprised, especially if we don’t account for the unexpected.

Consider, for example, the mixed economic data we saw this quarter. Housing and manufacturing data points were generally disappointing, as were employment and GDP numbers. Such statistics led some to believe that the economic recovery was, after five years, finally beginning to show signs of weakness. However, the particularly harsh weather this winter is believed by many to be the true culprit for poor economic performance this quarter, especially as hiring and consumer sentiment continued to rise.

Given this varied data, some questioned if the Fed would alter the timetable for tapering its quantitative easing program, especially as Janet Yellen took the helm of the central bank in February. Instead, Yellen, at her first FOMC meeting in March, stated that tapering is planned to continue on schedule. Conversely, the new Federal Reserve Chair also expects rates to remain low “for some time”. While job creation was the driver for this decision, the Fed has decided to revamp forward rate guidance, dropping the 6.5% unemployment target in favor of a broader set of economic measures. While some were concerned when the Fed went into specifics about the timing of a rate hike, it seems that the U.S. economy has so far absorbed the bumps in the road as we return to a more normalized monetary policy.

The same however, cannot be said for emerging markets this quarter. With so much of the market liquidity we’ve seen over the past five years flowing into emerging markets, the prospect of tightening monetary policy led many investors to reexamine the fundamentals of these economies. Several emerging market currencies experienced a great deal of volatility as a result, forcing central banks in some countries, notably Turkey and South Africa, to take tactical measures to stem the decline.

Chinese data further contributed to concerns about the growth prospects of the emerging world, with manufacturing numbers signaling a potential cooling of the world’s second largest economy. After China experienced its first corporate debt default this quarter, fears were further stoked about whether the Chinese economy has overextended itself, especially if growth is indeed slowing as many believe.

Global economic issues weren’t the only factor driving significant market volatility over the past few months. The Euromaidan protests in the Ukraine led to the ouster of pro-Russian President Viktor Yanukovych in February, as the country remained divided on whether to establish deeper ties with the European Union or Russia. By March, Russia had annexed the Crimean peninsula, after a supposed majority of Crimeans voted in a referendum to do so. While the EU and US have responded with sanctions on Russia, the situation in the Ukraine ultimately remains in a state of flux.

Overall, it seemed as though no matter where one looked at the beginning of 2014, there were storm clouds on the horizon. Many of the world’s “hot spots” only seemed to get hotter, and economic data in both the developed and emerging world was unimpressive at best. Amid all of this, many have continued to remind us that the bull market we’ve been enjoyed for the past five years is showing signs of age. Equity valuations, in markets both public and private, seem stretched, and in some sectors, inflated. While this isn’t an encouraging sign, it serves as a good time to reexamine views on growth not just for this year, but in years to come.

Having taken some time to consider the global growth story, we believe there are still plenty of reasons to remain optimistic. Innovative companies developing new technologies are meaningfully disrupting a wide variety of industries. Too often media attention is focused upon social media or flash in the pan mobile apps, leading many to question the true value of growth in this industry. However, not enough credence is given to impressive advances in areas like clean technology, healthcare and energy, which seem to be only the beginning of what’s to come. This argument becomes even more compelling when one considers that there are rapidly growing tech sectors not only in Silicon Valley or New York, but also in Dublin, Tel Aviv and as far afield as Nairobi.

Tech innovation is now a global phenomenon. With innovators now just as likely to be from the emerging world as they are in developed markets, we are likely to see solutions that can further spread prosperity and solve the issues we face in a globalized world. With that in mind, it becomes tough to agree with market pundits who see an end to emerging markets growth. Such sentiments have been expressed time and again, failing to account for the demographic dividend these markets possess, as well as their current and potential purchasing power. Ultimately, we feel growth in emerging markets is far from over, especially as these markets become innovators in their own right.

While we view these factors as part of a secular trend toward global growth, we recognize there is likely to be turbulence along the way. As compelling opportunities in global equity and fixed income markets become more elusive, we take this as a sign we may be due for choppier conditions in the not too distant future. As such, we have continued to work to better position ourselves against near-term risks, no matter what lies ahead.

As always, we welcome your thoughts, and greatly appreciate your support and trust.

Legal Information and Disclosures

This memorandum expresses the views of the authors as of the date indicated and such views are subject to change without notice. Drum Hill Capital, LLC (“Drum Hill Capital”) has no duty or obligation to update the information contained herein. Further, Drum Hill Capital makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Drum Hill Capital believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Drum Hill Capital, LLC.


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